Tuesday, August 3, 2010

The next few months will be critical to choosing our economic path. We are staring into the face of the expiration of the Bush tax cuts and a Budget Commission's report likely to include calls for massive new taxes. Moreover, we may well see Republicans regain the House if not the Senate. If so, are they brave enough to actually address America's economic problems?

One unique characteristic of America has long been optimism about the future - that things will inevitably get better, not just for our generation, but for our children. No more. We now expect that our children and grandchildren will experience a lower standard of living. According to a Fox News poll, over 62% of Americans today think America is in decline and most see America as in the middle of transitioning from capitalism to socialism.

Americans have good reason to be pessimistic at the moment. As the WSJ explains:

Americans say they are underwhelmed by the economic recovery, and yesterday's report of 2.4% growth in the second quarter met their expectations. A recovery that should be accelerating after the long and deep recession has instead downshifted into slower growth. . . .

The irony is that businesses and consumers have been fixing their balance sheets even as the government has been doing the opposite. States and localities have deficits of nearly $100 billion, while the federal hole will be close to $1.4 trillion for the second year in a row.

This implies higher taxes, which Democrats in Washington are promising to deliver on January 1, and that's only the first installment. So just as Americans are putting themselves in the financial condition to start investing and spending more robustly, the Obama Administration will suck tens of billions out of the private economy. This is not the way to nurture a recovery that is weaker than it should be. . . .

A robust recovery would be building momentum, especially with historically easy monetary policy continuing. Instead this one is plodding along . . .

The epic government stimulus has failed to produce the robust expansion the White House promised, and the prospect of higher taxes and more regulation is inhibiting the private animal spirits needed for growth to accelerate. Americans may have to wait for November for Washington to get that message.

Obama and the left, having multiplied our national debt by a factor of nine since taking control of our national purse strings in 2007, show no inclination to limit spending. Indeed, having wasted a significant portion of the $787 billion dollar stimulus propping up profligate states and their public union workers, the left is now busy trying to funnel yet more of our tax money to states as the stimulus funds run dry.

On the back of such massive wasteful spending, these same people have been busy passing far reaching legislation that will make it more difficult for businesses to profit and for markets to function. In the rush to enact Obama's sweeping agenda, few if any paused to read, let alone consider, the fine print.

For but one example, Obama'snew financial regulationsstripped legal protections from bond rating agencies, subjecting them to liability for their expert opinions. As soon as the law went into effect last week, rating agencies told their clients that they could no longer use their bond ratings in bond-registration statements. Such statements are required by law for the issuance of bonds offered for public investment. This will drive the issuance of virtually all new bonds into the private market. At a minimum, this will slow the pace of issuance of municipal bonds and eventually drive the costs of borrowing higher, perhaps significantly so. As an aside, I am not suggesting for a moment that bond rating agencies should be exempt from responsibility for their ratings. It was a major contributing cause to our financial meltdown. But this law was not the way to do it. Indeed, this law would not have been crafted any differently if its main purpose was to bring havoc to our bond markets.

Yet another prime example was the Obamacare provision that small businesses have been screaming about - the one that will require all businesses to file tax forms for every vendor that sells them more than $600 in goods. This will entail a massive expansion of paperwork for both businesses and the IRS and it will prove a very significant burden on small businesses. Even Democrats now understand that what they passed is a time bomb for our economy. Yet having passed the bill, they are refusing to repeal it unless Republicans agree to allow the Dems to borrow the $19 billion the provision was supposed to add to government coffers over the next decade. Republicans are demanding that the $19 billion be paid for from existing funds as required by the Pay As You Go legislation Obama signed into law several months ago. (The Democrats passage of pay go legislation is proving to be, as I opined at the time, perhaps the most cynical act to come out of our government in decades - and that is saying a lot.)

As I documented here, small business are not hiring or otherwise expanding, waiting to see what new liabilities they will face from a Democratic administration that seems determined to punish our economy. Large business are doing the same. As the editors of IBD recently opined:

How do you keep an economy from digging itself out of a major recession? One surefire method is massively expanding a government whose major programs are already on their way to bankruptcy, then sitting idly by as major tax increases arrive.

The Democratic Congress has spent a trillion dollars on a failed Keynesian stimulus that promised millions of jobs that never materialized. They added a massive new entitlement in the form of a government takeover of health care when the entitlements already burdening us are going broke. And they are letting the Bush tax cuts expire at the end of this year.

Why in such a chancy economic environment would investors invest? Why would entrepreneurs take risks? And why would businesses expand and hire new employees? By extension, why would consumers spend?. . .

The answers to those questions seem obvious, but they apparently are a mystery to the left and their water carriers, particularly those at the NYT. For perhaps the most sophomoric commentary written by anyone on this topic - or any other topic, for that matter - do see NYT Columnist Bob Herbert's recent column, A Sin and a Shame. In it, he demonizes the profit motive and tells us that corporations should be required to maximize jobs as a public benefit rather than maximizing profits on behalf of the corporation's owners and investors. Of course, he is being paid by the NYT, a paper that recently ran an editorial advising us that deficits do not matter while coming out in favor of ever more public spending supported by a combination of massive new taxes and cuts in an already dangerously low defense budget.

Like Marx before him, class warfare is the major animating factor of Obama. His entire Presidency has been predicated on demonizing and squeezing businesses and the "rich," a group which for Obama includes people pulling in $250,000 a year. That's not quite Jed Clampett territory, but be that as it may, the truth of our still partially capitalist economy is that the "rich" are the ones who invest in businesses, who fund start ups, and who spend their money. As the AP recently reported:

Economists say overall consumer spending has slowed mainly because the richest 5 percent of Americans -- those earning at least $207,000 -- are buying less. They account for about 14 percent of total spending. These shoppers have retrenched as their investment values have sunk and home values have languished.

In addition, the most sweeping tax cuts in a generation are due to expire in January, . . . The wealthy may be keeping some money on the sidelines due to uncertainty over whether or not they will soon face higher taxes.

Jee, do you think?

Rich people have both the time and inclination to minimize their tax burden. Exhibit one, Sen. John Kerry (D - Mass.) who recently parked his new $7 million yacht in Rhode Island to get around about half a million in Massachusetts state taxes. The truth is that Kerry is doing nothing that virtually all Americans do - minimize their tax burden.

The collary to that is that increasing the tax burden on high earners almost inevitably leads to a reduction in tax receipts and less economic growth, while limiting the burden has, for the past century, led to increasing tax receipts as the total of America's wealth expanded. Economist Art Laffer expanded upon this in the WSJ recently:

. . . [T]here is a false presumption that higher tax rates on the top 1% of income earners will raise tax revenues.

Anyone who is familiar with the historical data available from the IRS knows full well that raising income tax rates on the top 1% of income earners will most likely reduce the direct tax receipts from the now higher taxed income—even without considering the secondary tax revenue effects, all of which will be negative. And who on Earth wants higher tax rates on anyone if it means larger deficits? . . .

We all know that there are lots of factors influencing tax revenues from the rich, but the number one factor has to be the statutory tax rates government tells the rich they have to pay. Not only do the direct income tax consequences of higher tax rates on those in the highest brackets lead to higher deficits, the indirect effects magnify the tax revenue losses many fold.

As a result of higher tax rates on those people in the highest tax brackets, there will be less employment, output, sales, profits and capital gains—all leading to lower payrolls and lower total tax receipts. There will also be higher unemployment, poverty and lower incomes, all of which require more government spending. It's a Catch-22.

Higher tax rates on the rich create the very poverty and unemployment that is used to justify their presence. It is a vicious cycle that well-trained economists should know to avoid.

We will be reaching a real tipping point in the next few months. We will either begin taking the steps necessary to bring our national budget into long term health and creating an atmosphere in which businesses can expand, or we will be dooming our country to long term economic pain, if not catastrophe. I would like to be able to say that this is a choice between the plans of Obama and the plans of Republicans, but that does not seem to be the reality.

Republicans are licking their chops at major gains in November on a platform of simply not being Democrats. Admittedly, that is a major step forward, but it is not a solution to the long term economic problems that we face. Only one Republican, Rep. Paul Ryan, has articulated a real plan to address our severe national economic problems. It is his road map. It is a serious plan, but not one without pain.

Instead of embracing the plan, Republicans have shied away from it, apparently seeking to sell the same snake oil to America that Democrats are selling - that our problems can be fixed without pain and that the money tree is still growing an endless supply of dollars. This from the Washington Post:

. . . Ryan is running a campaign of a different sort, one his party has so far refused to adopt: He is determined to persuade colleagues to get serious about eliminating the national debt, even if it means openly broaching overhauls of Medicare and Social Security.

He speaks in apocalyptic terms, saying the debt is "completely unsustainable" and warning that "it will crash our economy." He urges fellow politicians, and voters, to stop pretending that this problem will go away on its own.

He administers his sermons with evangelical zeal. He will go anywhere and talk to anyone who will listen. When he is not writing op-eds and appearing on television, he can often be found speaking to liberal and conservative audiences alike about his "Roadmap for America's Future," a plan he says would fix the problem.

"Political people always tell their candidates to stay away from controversy," said Ryan, 40. "They say, 'Don't propose anything new or bold because the other side will use it against you.' "

While he does not name the "political people," they no doubt include many Republican colleagues, who, even as they praise Ryan for his doggedness, privately consider the Roadmap a path to electoral disaster. Unlike most politicians of either party, he doesn't speak generically about reducing spending, but he does acknowledge the very real cuts in popular programs that will be required to bring down the debt.

His ideas are provocative, to say the least. They include putting Medicare and Medicaid recipients in private insurance plans that could cost the government less but potentially offer fewer benefits; gradually raising the retirement age to 70; and reducing future Social Security benefits for wealthy retirees.

Of the 178 Republicans in the House, 13 have signed on with Ryan as co-sponsors.

Ryan's proposals have created a bind for GOP leaders, who spent much of last year attacking the Democrats' health-care legislation for its measures to trim Medicare costs. House Minority Leader John A. Boehner (R-Ohio) has alternately praised Ryan and emphasized that his ideas are not those of the party. . . .

What seems clear is that far too much of our Republican political class is out of touch with America today. Ask anyone in the Tea Party movement if they are ready to take the medicine necessary to put America back on an upward trajectory and I think the answer will be uniformly yes. The days when talk of reforming Social Security and Medicare were a recipe for disaster at the hands of demagoging Democrats are years in the past. Yet far too many of our Congressional Republicans still don't get it.

My greatest fear is not that Democrats will retain power of the purse strings come November, but that Republicans will win it - and then do nothing constructive. If so, then we as a nation are in deep trouble indeed.